Graco Inc.

Good morning and welcome to the second quarter conference call for Graco, Inc. If you wish to access the replay for this call, you may do so by visiting the company website at www.graco.com. Graco has additional information available in a PowerPoint slide presentation, which is available as part of the webcast player. At the request of the company, we will open the conference up for questions and answers after the opening remarks for management. During this call, various remarks may be made by management about their expectations, plans, and prospects for the future. These remarks constitute forward-looking statements for the purpose of the safe harbor vision of the Private Security Litigation Reform Act. Actual results may differ materially from those indicated as a result of various risk factors, including those identified in item 1A of the company's 2022 annual report on the Form 10-K in item 1A of the company's most recently quarterly report on Form 10-Q. These reports are available on the company's website at www.graco.com and the SEC's website at www.sec.gov. Forward-looking statements reflect the management's current views and speak only as of the time they are made. The company undertakes no obligation to update these statements in light of new information or future events. I will now turn the conference over to Chris Knutson, Executive Vice President, Corporate Controller.

Good morning, everyone, and thank you for joining our call. I'm here today with Mark Sheehan and David Lowe. I will provide a brief overview of our quarterly results before turning the call over to Mark for additional discussion. Yesterday, Graco reported second quarter sales of $560 million, an increase of 2% from the second quarter of last year. The effect of currency translation decreased sales by one percentage point, or approximately $3 million. Reported net earnings increased 14% to $134 million for the second quarter. Diluted net earnings per share was 78 cents, an increase of 15% over last year. After adjusting for the impact of excess tax benefits from stock option exercises, diluted net earnings per share was 75 cents. Based on current exchange rates, currency translation should have no effect on full year net sales or earnings. We expect the unfavorable effects of currency that we saw in the first half of the year will be offset by favorable impacts in the second half. The gross margin rate increased 310 basis points in the quarter. strong price realization plus favorable product and channel mix, mainly in the contractor segment, was more than enough to offset higher product costs. While material cost increases have moderated compared to what we experienced last year, headwinds from lower factory volumes and increased factory spending have put pressure on the gross margin rate for the quarter and year to date. Factory volumes have softened as the year progressed, as lead times, supply chains, and customer order trends start to normalize. Total operating expenses increased $14 million, or 12% in the quarter, primarily from rate-based increases of $6 million and incremental share-based compensation of $4 million. Gross margin rate improvement more than offset these increased operating expenses during the quarter, resulting in operating margin rate growth of 1 percentage point. contractor operating margin increased one percentage point compared to the second quarter last year. Sequentially, contractor operating margin decreased three percentage points from the first quarter, largely due to new product development spending, unfavorable channel mix, and unfavorable factory volume related to inventory reduction initiatives. For the full year, we expect unallocated corporate expenses to be approximately $34 million to $37 million, but timing can vary by quarter. Non-operating expenses decreased $5 million as a result of increased interest income on cash held and the favorable effect of market valuation changes on investments held to fund certain retirement benefits. The adjusted tax rate was 19% for the quarter, which is consistent with our expected full-year tax rate of approximately 19% to 20% on an as-adjusted basis. Cash provided by operations totaled $282 million for the year, an increase of $147 million from last year, mostly driven by higher net earnings and a reduction in inventory purchases. Cash provided by operations as a percent of net earnings is 107% for the year. Significant uses of cash year to date were dividend payments of $79 million and capital expenditures of $92 million. We estimate capital expenditures for the year to be $200 million, with $130 million related to facility expansion projects. Finally, subsequent to year end, or quarter end, we repaid $75 million of our private placement debt, including a prepayment fee of $700,000, which will be recognized as interest expense in the third quarter of this year. I'll now turn the call over to Mark for further segment and regional commentary.

Thank you, Chris, and good morning, everybody. All my comments this morning will be on an organic, constant currency basis. Sales were up 3% for the quarter. We achieved record second quarter revenue and operating earnings, driven by strong results in both the process and industrial segments. Contractor performance remained mixed, with growth in pavement, protective coatings, and spray foam unable to offset softer sales in the home center and pro paint channels. EMEA was a bright spot during the quarter growing 5% compared to last year with growth in all reportable segments. Incoming order rates and many key product categories have been solid and sales have improved as many of the adverse component and product availability issues that impacted EMEA last year have improved. Operating margins were strong for the quarter as we continue to benefit from our pricing actions in 2022 and 2023. Price realization in the businesses and regions accounted for nearly all of our revenue growth and significantly contributed to our company-wide incremental margins of 75%. With similar volumes and costs for the rest of the year, we expect to continue to see solid margin performance for the remainder of 2023. Our consolidated backlog was $330 million at the end of the quarter, down $20 million from the end of last quarter. Issues with supply chain and component availability have improved modestly. Better component availability has allowed us to increase our customer service levels, although we still have room for improvement. Now, turning to some commentary on our segments. The contractor segment experienced a low single-digit revenue decline in the second quarter, driven by less demand in the home center channel, slowing construction markets in China, and softer demand in the North America propane channel. Somewhat offsetting these headwinds were growth in our pavement and high-performance coatings and spray foam businesses. New product introductions were also incrementally favorable for both the quarter and on a year-to-date basis. We believe that the current inventory levels within the home center channel are reflective of foot traffic in the stores and out-the-door sales. The decline in the North America propane channel compares to strong second quarter sales last year when we made a significant dent in our back orders to key customers after component shortages started to ease. Growth in EMEA during the quarter was largely due to improved product availability and strong price realization. Asia Pacific, on the other hand, declined 6% as the shipping container business and construction markets were weaker than a year ago, especially in China. Despite the soft quarter, we are optimistic for the balance of the year as contractor activity remains solid, and we are seeing improvement in key economic data related to U.S. housing starts and existing home sales, along with continued strength in commercial construction spending. The industrial segment grew 4%, resulting in record second quarter revenue and operating earnings. Activity in key end markets such as alternative energy, electronics, and battery has been robust. Incoming orders in our liquid finishing and sealant and adhesive businesses remain solid, but we're somewhat offset by continued softer demand in our powder finishing business, especially in Asia Pacific. However, backlogs in powder equipment and systems remain elevated, giving us confidence for a better second half of the year. The process segment grew sales 14%, resulting in second quarter records for both revenue and operating earnings. This is the 10th consecutive quarter that process has set these records. We saw continued broad-based sales growth in all product categories. However, vehicle service, automatic lubrication, and semiconductor were the key drivers of the impressive performance this quarter. Steady volume. Strong pricing and good expense management resulted in incremental margins of 76% for the quarter and operating earnings of 31%, which is another record for the segment. At similar volumes, we believe the current operating margin rate is sustainable, and we are pleased with the strong margin progression that has occurred in this segment the last two years. Moving to our outlook. Our results for the first six months were essentially in line with our expectations. End market activity can be broadly characterized as having pockets of both strengths and weaknesses. Overall, we're seeing modest sales growth drive strong earnings leverage. Current order rates, along with elevated backlogs, give us confidence that we will attain our full-year revenue guide of low single-digit organic growth on a constant currency basis. That concludes our prepared remarks. Operator, we're ready for questions.